Decoding the Fed

By John Mauldin


“In the economic sphere an act, a habit, an institution, a law produces not only one effect, but a series of effects. Of these effects, the first alone is immediate; it appears simultaneously with its cause; it is seen. The other effects emerge only subsequently; they are not seen; we are fortunate if we foresee them.

There is only one difference between a bad economist and a good one: the bad economist confines himself to the visible effect; the good economist takes into account both the effect that can be seen and those effects that must be foreseen.

Yet this difference is tremendous; for it almost always happens that when the immediate consequence is favorable, the later consequences are disastrous, and vice versa. Whence it follows that the bad economist pursues a small present good that will be followed by a great evil to come, while the good economist pursues a great good to come, at the risk of a small present evil.”

Frédéric Bastiat, “That Which Is Seen and That Which Is Unseen,” 1850

You may have noticed strange events in Washington, DC—strange even by today’s standards—and I don’t mean the White House or Capitol Hill. I’m talking about Federal Reserve policy.

In less than 12 months we have seen the Fed raise rates, cut rates, shrink its balance sheet, expand its balance sheet, inject liquidity, withdraw liquidity, and do who knows what else behind the scenes. Either Fed officials are confused or we are at some kind of economic turning point. Or possibly both—there is no playbook. At a minimum, I think we are at a turning point and the Fed is having to improvise policy as events dictate.

Observing all this, it’s easy to fixate on the present and forget what led to it, those “seen and unseen” effects Bastiat described. At times like this, it helps to take a step back and review the process that got us here. Today we’ll do that, considering the latest Fed activity in longer context.

That’s what the Fed does, after all, and understanding them may be easier if we try to think like them.

First, a small request. I am trying to learn more about the Japanese pharmaceutical sector and regulations and in particular looking for a potential biotechnology partner. I will be eternally grateful to any readers with contacts at senior level management who would be willing to make an introduction. If that’s you, drop me a note here. Many thanks.

Six Bears

We’ll start by noting six events/trends, in no particular order because they’re all important.

First, worldwide economic growth is weakening, with some key markets approaching recession. This week the International Monetary Fund reduced its 2019 global growth forecast to 3.0%, the lowest since 2009 when recession was still underway. They think it will improve to 3.4% in 2020.

That’s better than the alternative but not much of a recovery.

Note, that’s the global average, which would be lower without considerably above-average growth in China and India. IMF pegs US growth at closer to 2%, with Japan and most of Europe even lower. Problems in China could worsen the IMF’s outlook quickly.

Second, if you don’t want to believe the IMF (and there’s reason to be skeptical), look at global shipping trends. The economy is increasingly digitized but the movement of physical goods is still its circulatory system.
The latest Cass Freight Index data shows global blood pressure is dropping, when looking at the trends on both the total shipment and expenditures basis. Shipping volume has been down for 10 straight months on a year-over-year basis (hat tip Peter Boockvar).

Third, monetary and fiscal stimulus is proving less effective. Not that it was so great last time, but it helped. It also had side effects that may have reduced its usefulness. You can’t force credit on those who don’t want or need it, even at zero or negative rates. The European Central Bank and Bank of Japan are learning this the hard way.

On the fiscal side, the 2017 US corporate tax cut helped but the trade war offset some of it. Other countries, because they don’t have the dollar’s “exorbitant privilege,” have less fiscal flexibility than the US. Hence we see, for instance, Mario Draghi practically pleading with European governments for more stimulus spending and those governments shrugging their collective shoulders. They can’t do it.

Fourth, the US budget deficit is huge and growing. As I’ve shown, a recession in the next few years will likely push it far higher as revenue drops and spending rises. The Treasury’s increased borrowing is also having an effect on credit markets.

The investors who aren’t plunging into stocks seem to be holding more cash. Money market balances have been creeping up. A little caution might seem to be in order, but it matters where investors store their cash. If it’s not available for the banking system to grease its wheels, bad things can start happening. (More on that in a minute.)

Fifth, we are starting to see confidence break in important corners of the capital markets. The WeWork IPO turned into a fiasco. In fact, the entire company looks just like the train wreck Grant Williams said it would be. I don’t see how anybody could look at the business model of WeWork and not see an obvious hustle. What does that say about the supposedly brilliant venture capitalists who threw cash at the company? Nothing good. Though maybe they knew what it was and just figured they could flip their shares to the public before it fell apart. If so, they appear to have been wrong.

But the broader point is that once-invincible Silicon Valley unicorn companies are losing their allure. It turns out business success is hard when you have to actually, you know, generate more revenue than expenses. Other WeWork-like stories are probably coming. Nor is it just unicorns; look at Boeing’s struggle to fix the 737 Max planes, and the shortcuts we are learning it took. These are bad signs for a market that needs earnings growth if it is to maintain current prices, much less see them rise further. (Note: I would not be afraid at all of flying a 737 Max on a US carrier. Just saying…)

Sixth, as I was wrapping up this letter, the latest Ambrose Evans-Pritchard column hit my inbox. He read the IMF’s latest financial stability report and came away with a distinctly darker view:

The International Monetary Fund has presented us with a Gothic horror show. The world’s financial system is more stretched, unstable, and dangerous than it was on the eve of the Lehman crisis.

Quantitative easing, zero interest rates, and financial repression across the board have pushed investors—and in the case of pension funds or life insurers, actually forced them—into taking on ever more risk. We have created a monster.

There are ‘amplification’ feedback loops and chain-reactions all over the place. Banks may be safer—though not in Europe or China—but excesses have migrated to a new nexus of shadow-lenders. Woe betide us if this tangle of hidden leverage is soon put to the test.

According to the IMF, globally there is about $19 billion of “debt-at-risk,” in which a global slowdown and/or recession would render borrowers unable to make their payments. I have written a great deal about the high-yield and leveraged loan market in the US, but globally it is much worse.

“In France and Spain, debt-at-risk is approaching the levels seen during previous crises; while in China, the United Kingdom, and the United States, it exceeds these levels. This is worrisome given that the shock is calibrated to be only about half what it was during the global financial crisis,” it said.

…In Europe, almost all leveraged loans are now being issued without covenant protection. The debt to earnings (EBITDA) ratio has vaulted to a record 5.8. Is the ECB asleep or actively promoting this?

The IMF’s directors call for “urgent” action to stop these excesses but in the same breath suggest/admit that the cause of leverage fever is the easy money regime of the authorities themselves—that is to say the central banks and their political masters who refuse, understandably, to permit debt liquidation and to allow Schumpeter’s creative destruction to run its course in downturns.

This is all going to cause precisely the crisis that I mentioned last week with pension funds. There is no way they can make the returns they need to meet their obligations. The next serious global recession/bear market will create a death spiral for many pension funds, requiring extraordinarily painful bailouts, to the point where they may simply default on the obligations. Don’t think that it can’t happen.

So that’s a quick survey of where we are. Now let’s add something else to the mix.

Repo Weirdness

Banks are a place where you store your cash, right? Not exactly.

When you deposit money in a checking or savings account, you aren’t just letting the bank hold it on your behalf.

You are lending the bank that money and the bank is borrowing it. That’s why deposits show as a liability on the bank’s balance sheet.

We think of banks as lenders, and they are, but they’re also borrowers. They make money by lending at higher rates than they pay borrowers, and by leveraging their deposits via fractional reserves.

This is obvious if you think about it. How can your bank simultaneously a) promise you can withdraw your cash on demand and b) lend that same cash to someone else?

That’s possible only because they know only a few people will want their cash back on any given day. And if cash requirements are more than expected, they can borrow from other banks or the Federal Reserve, as needed.

Modern central banking and regulatory practices have practically eliminated the old-fashioned bank run. It still happens occasionally, but the system can absorb it. That’s because, while depositors can withdraw cash from a given bank, it is hard to withdraw from the banking system. Even if you buy gold, the gold dealer will probably deposit your cash in their bank, leaving the system exactly where it was before.

Now, the system is vulnerable if too many people decide to hold physical paper money, or they transfer deposit money into other instruments banks can’t leverage as easily. Central bank reserve requirements also play a role. The banking system is far more elaborate than the most complicated Swiss watch but it just keeps on ticking… until it stops.

Something weird happened in September, for reasons that remain a little murky. The repurchase agreement or “repo” market seized up. I’ll spare you a plumbing lesson; all you need to know is that repos are really, really important for overnight funding. Without them, it’s very hard for banks, brokers, funds, and other market participants to square their books. Modern banking simply wouldn’t function and the system would shut down.

Now, this wasn’t a catastrophe. The Fed injected some liquidity and everything seems okay for now. The important part is that it shouldn’t have happened and worse, apparently no one saw it coming.

We had a string of similar hiccups in 2007–2008. All were manageable but eventually they added up to something much worse. So, this wasn’t a good sign for market stability.

That’s the problem with unconventional monetary policy. It may solve your immediate problem but create bigger ones later, just as Bastiat said. We now know the Fed’s 2017–2018 rate hikes, concurrent with the balance sheet reductions or “QT” (quantitative tightening) was probably too aggressive, as even the Fed now tacitly admits. I said at the time they were running a two-factor experiment with unpredictable results. Could we now be seeing them? And if so, are they over?

No one knows, but the Fed looks rattled. And a rattled Fed isn’t what we need.

“Ample Supply”

The Federal Open Market Committee had an unscheduled meeting on October 4.
That happens occasionally and they often don’t reveal it occurred until the next regular meeting.
That would mean Oct. 30, in this case.

But for some reason (and you can bet they had a reason) they decided to announce this one on Oct. 11. In between, Fed Chair Jerome Powell said in an Oct. 8 speech that the Fed would soon start growing its balance sheet again.
He characterized the move not as QE, but as a more permanent operation to make sure the Fed has enough reserves to deal with market volatility.

To be fair, let’s read Powell’s own words, :

In mid-September, an important channel in the transmission process—wholesale funding markets—exhibited unexpectedly intense volatility. Payments to meet corporate tax obligations and to purchase Treasury securities triggered notable liquidity pressures in money markets. Overnight interest rates spiked, and the effective federal funds rate briefly moved above the FOMC's target range. To counter these pressures, we began conducting temporary open market operations. These operations have kept the federal funds rate in the target range and alleviated money market strains more generally.

While a range of factors may have contributed to these developments, it is clear that without a sufficient quantity of reserves in the banking system, even routine increases in funding pressures can lead to outsized movements in money market interest rates. This volatility can impede the effective implementation of monetary policy, and we are addressing it. Indeed, my colleagues and I will soon announce measures to add to the supply of reserves over time. Consistent with a decision we made in January, our goal is to provide an ample supply of reserves to ensure that control of the federal funds rate and other short-term interest rates is exercised primarily by setting our administered rates and not through frequent market interventions. Of course, we will not hesitate to conduct temporary operations if needed to foster trading in the federal funds market at rates within the target range.

So the Fed needs ample reserves to do its job. Fair enough. But until the last decade, a fraction of the current level sufficed. Now we are told the Fed needs far more reserves and it needs them permanently.

We have reached a point at which the Fed believes it must have nuclear weapons just to swat flies. I am sorry but that doesn’t inspire confidence it will handle the next crisis well.

At the risk of saying I told you so, I said many times that reducing the Fed’s balance sheet at the same time they were raising interest rates was a major mistake. Some market analysts believe one of the causes of the repo crisis was the adjustment to that Fed balance sheet.

Note also, the Fed can only buy Treasury bills to the extent the Treasury issues them. That means a shorter maturity on our large and growing federal debt, further implying government borrowing costs could spike quickly at some inconvenient future point.

There will be other effects, too. The Fed’s new buying at the short end will probably steepen the presently-inverted yield curve to a more normal shape. That might reduce recession worries, but it probably shouldn’t. The inverted yield curve is a symptom of the pressures that lead to recession. Manipulating the inversion away won’t solve the underlying problems. The horse is out of the barn, already in the north 40 and still running.

This could go many different directions, and that is the problem. Remember the sandpile analogy. It is inherently unstable and anything could set off a collapse. Our highly leveraged banking system is also inherently unstable, not accidentally but by design. It needs huge leverage to function in the way bankers want it to. And as noted, the central banks are pretty good at keeping the sandpile intact. But they aren’t perfect, and when they fail it tends to be ugly.

Add in the other stress factors I mentioned above, and it’s hard to see how we avoid some kind of crisis in the relatively near future. I don’t know where it will begin but I’m pretty sure it will be somewhere in the debt markets.

Seven Deadly Sins

I also wanted to report that our “7 Deadly Economic Sins” Week is a great success. Today’s video clip is Lacy Hunt, former senior economist at the Dallas Fed, discussing the unsustainable national debt. Make sure to watch for my email in your inbox. And then we’ll end the week with a bang by having Bill White and Grant Williams talk about the insanity of negative interest rates.

We got many reader comments and questions about the “7 Deadly Economic Sins,” the likely root causes of the coming global economic crisis. Let me just say that even though some of these prospects are scary, it won’t be the end of the world.

It never is; it just sometimes feels like it.

Knowledge is power when it comes to preventing excessive damage to your personal life and assets. Knowing what to expect can give you the head start that you need to escape unscathed. Like those few with enough foresight to get out of Zimbabwe or Yugoslavia before the roof came down.

So my team and I are putting together a special package for you that, if you take us up on the offer, will greatly increase your knowledge of what’s to come. I’ll have more on that next week.

New York, Houston?, Philadelphia?, And…?

I will be in New York Monday and Tuesday for a series of meetings before flying back home to write next week’s letter. In November I will visit Philadelphia to explore new biotechnology potential, along with several meetings in Houston with my SMH partners. We’ll be looking at potential new investments for my readers and clients. There really is power in my network.

Today I do something unusual and play golf on a Friday. My friend and business associate Brian Lockhart of Peak Capital is in Puerto Rico looking at its investment potential. He’s an avid golfer and I live on a TPC course. Even better, he’ll spend the night. Brian is the seemingly endless source of great stories.

Shane comes home from Dallas late tonight. She went to close down our apartment there as we just don’t get back enough to justify renting one. Airbnb or hotels make a great deal more dollar sense. She’s also putting her rental homes in Denison on the market, as it is hard to be a landlord from a few thousand miles away.

And with that I will hit the send button. You have a great week. Let’s hope that somehow a reasonable Brexit process emerges, along with a truce in the tariff wars. A little success that tones down the rhetoric would certainly help stave off a recession next year, all things considered.

Your needing to get to the gym more analyst,


John Mauldin
Co-Founder, Mauldin Economics

Luxury real estate has a long way to fall

The commercial market, which has been in a bubble for some time, is finally deflating

Rana Foroohar

Real Estate Rise and Fall
© Matt Kenyon

Luxury real estate is over. I hate to say it and — as someone who has a large percentage of her net worth tied up in a Brooklyn townhouse — I’m talking against my own book. But it is true.

For years, cities including London, New York, San Francisco and Los Angeles, have been largely disconnected from national property market trends. Such places seemed to be a class by themselves, buoyed by being at the right end of a bifurcated global economy. Former New York City mayor Michael Bloomberg once likened the Big Apple to a “luxury product” for which people are prepared to pay an exorbitant premium.

Except they aren’t any more. The prices of luxury apartments in Manhattan are falling for the first time in 10 quarters, and it’s the fastest annual drop since 2011, according to Miller Samuel, a New York-based real estate consultant.

“The upper third of the market is characterised by elevated inventory” and sellers who have been “anchored to 2016-2017 prices,” says president Jonathan Miller. But buyers are waiting longer than ever before to jump, because of recessionary fears, and the (even) lower interest rates that they might herald.

At the same time, the commercial market, which has been in a bubble for some time, is finally deflating. US Federal Reserve officials have been saying for some time that the commercial market was overheated, even as US banks have made $700bn worth of commercial real estate loans since 2012. Now WeWork — a company that has become a symbol of all things frothy — is at the centre of what may be a sustained drop in commercial prices in New York and London.

The property company, which recently scrapped its initial public offering, is the largest private sector office tenant in both cities. As it has imploded, so has an £850m commercial deal in London that was home to one of WeWork’s largest sites. In New York, the company has basically been forced to stop signing new leases.

You could argue that some deflation would be healthy — according to a recent Goldman Sachs report, commercial real estate prices in New York are now 42 per cent above 2007 levels and 108 per cent above post-recession lows.

The Boston Federal Reserve president, Eric Rosengren, and San Francisco Fed president, Mary Daly, have recently called out risks in the sector. The MSCI US Reit Index has quadrupled in value over the past decade as investors have searched, often desperately, for yield. A correction at this stage of the cycle would perhaps be only natural.

But I think we could be at the beginning of a sea change in top markets, for a number of reasons. In the UK, Brexit has created huge uncertainties for prime London tenants and buyers. Meanwhile, in the US, the Committee on Foreign Investment in the United States (Cfius), which reviews and approves foreign investment deals, has proposed new rules that would expand scrutiny of such deals into real estate, an area that had previously been passed over.

Now, if an overseas buyer wants to make a big real estate purchase, it could be subject to the kind of scrutiny that ultimately blocked the Singaporean telecoms company Broadcom’s $142bn bid for US chipmaker Qualcomm last year. This is bad news for prices, which have long been buoyed at the top end by foreign buyers for both commercial and residential property. When I purchased my New York home in 2007, I was coming from London and bidding against a Brazilian and a German.

Prices in the most sought-after cities will also be depressed longer term by the fact that millennials — many of them underemployed and burdened by student debt — will be unable or unwilling to buy properties that baby boomers are looking to sell. About three-quarters of the US is now “housing unaffordable” for average wage earners.

That is one reason there has actually been a pick-up in the entry level housing market in places such as Detroit or Austin or Portland. Young people need to be where the jobs are, but they also need apartments they can afford, and those are easier to find in so-called second tier cities.

The question is how long those cities will remain affordable. Portland, for example, is starting to grapple with a housing affordability crisis of its own.

Perhaps a collapse in prices in prime urban areas will bring all those millennials back to co-working spaces in New York and London. Or perhaps, as remote work becomes more and more prevalent, everyone — individuals and corporations — will realise that it is easier, cheaper and more environmentally sound for workers to stay where they are and not commute to prime office spaces in luxury cities where they pay more for lattes and square footage alike.

The current market correction might help push things in the latter direction. Dan Alpert, managing partner at Westwood Capital, an investment bank, has calculated that if WeWork were removed from the New York property equation, the Manhattan market would have had a net loss of 700,000 sq ft of new leased space, rather than gaining the 2.3m sq ft that it did in the 24 months leading up to last June. A lot of that demand came from the euphoria created by tech-driven markets that are now correcting.

Stocks and property prices in prime areas still have quite a way to fall.

Donald Trump and Boris Johnson have weaponised the will of the people

The ‘by any means necessary’ approach is fuelling an Anglo-American democratic crisis

Gideon Rachman

© Efi Chalikopoulou

“By any means necessary” is the slogan used in 10 Downing Street to describe UK prime minister Boris Johnson’s approach to Brexit. The same phrase encapsulates Donald Trump’s approach to re-election in 2020.

The consequences of this attitude to government became clear last week, as rule-of-law crises broke out on both sides of the Atlantic. In the UK, the Supreme Court ruled 11-0 that the Johnson administration had acted unlawfully in suspending parliament. On the same day, an impeachment inquiry began against the US president, prompted by a whistleblower’s claim that Mr Trump pressured the government of Ukraine to dig up dirt on his political opponents.

These concurrent crises are more than a coincidence. They are signs that the laws and conventions that underpin liberal democracy are under attack in both the UK and the US, two countries that have long regarded themselves as democratic role models for the world. In normal times, a British or American government would have responded to the legal blows dealt to them last week with caution, restraint — and even contrition.

But those days are gone. Instead, the Trump and Johnson camps are whipping up their supporters to believe that their legal problems are an act of revenge by political enemies intent on thwarting the will of the people.

Mr Johnson has combined a pro forma acceptance of the court ruling with a claim that the Supreme Court judges were wrong (all 11 of them). His allies continue to splutter that the court is made up of metropolitan Remainers. Questioning the independence of judges has long been part of Mr Trump’s rhetoric. During the 2016 election, he suggested that a Mexican-American judge would inevitably be biased against him because of his stance on immigration.

Contempt for the rule of law is baked into the “by any means necessary” approach to politics.

In the UK, the Johnson adviser who adopted the motto is Dominic Cummings, who in a rambling blog post this year expressed his frustration that, in government, “discussions are often dominated by lawyers” — and that these killjoys often deemed his bright ideas “unlawful”.

Once you have asserted that the end justifies the means, then any tactic is logically permissible. It is telling that “by any means necessary” was a slogan originally adopted politically by Malcolm X, the African-American activist of the 1960s, who was frustrated by the non-violent methods of the civil rights movement. The implied threat of violence is already part of the Trump-Johnson playbook.

After MPs complained last week that the prime minister’s language was encouraging attacks on politicians, Mr Cummings’ response was that it is unsurprising people are angry and that the best way to soothe their righteous anger is to get Brexit done. Mr Trump has said that the whistleblower in the Ukraine case is “almost a spy”, and suggested he should be handled as “in the old days, when we were smart” (in other words, executed). In the past, Mr Trump has encouraged crowds at his rallies to rough up protesters.

The political arguments made by both the Johnson and Trump administrations use the language of democracy, but the underlying logic has more in common with populist authoritarianism. For Mr Johnson, the narrow Brexit referendum victory of 2016 trumps all the other constraints that operate in a democratic society, including the law, the truth and the will of parliament and its elected representatives.

Mr Trump has even less regard for the idea that democracy comes with checks and balances. His sense of himself as the tribune of the people is fed by his own ego and the devotion of his supporters. He once said that he could shoot somebody on New York’s Fifth Avenue, without losing votes.

When leaders such as Mr Johnson and Mr Trump claim a direct mandate from the people, then the other institutions of a democratic society can be treated with contempt, and even threatened with violent retribution at the hands of the people. America has been moving down this populist-authoritarian road ever since Mr Trump entered politics. Britain lagged behind for some time, under the more conventional and honourable leadership of Theresa May. But a cornered and unscrupulous Mr Johnson has now imported Trumpian politics to the UK.

All is far from lost. The decisions of the UK Supreme Court and the House of Representatives last week demonstrated that, in Britain and America, the law remains a formidable restraint on leaders with authoritarian instincts.

But this is just one stage in the battle. The Johnson-Cummings strategy is to get to an election and then fight it on a “people against the establishment” ticket. Mr Trump will wage a similar campaign in 2020. Weekly podcast

Sign up here to the new podcast from Gideon Rachman, the Financial Times chief foreign affairs columnist, and listen in on his conversations with the decision-makers and thinkers from all over the globe who are shaping world affairs.

Facing divided, radicalised and unconvincing political opponents, the Trump-Johnson strategy could yet triumph. That strategy, it should now be clear, involves contempt for the rule of law, the trashing of national institutions, fostering an atmosphere of violence and deliberately widening bitter divisions within the country.

Until recently, Britain and America could serve as genuine inspirations to liberals around the world, showcasing what a law-governed democratic system should look like. The degeneration of liberal democracy in its Anglo-American heartlands will, sadly, have a global impact.

Another fine mess

Donald Trump triggers a Turkish invasion and trashes the national interest

The Syrian regime makes hay; so do the Russians

BASHAR AL-ASSAD surely cannot believe his good fortune. For six years the Syrian dictator has had little control over the north-east of his country, home to Syria’s modest oilfields and some of its most fertile farmland. The jihadists of Islamic State (IS) seized power there in 2014. As their caliphate crumpled, a Kurdish-led militia which was doing much to bring about that crumpling took over, establishing an autonomous fief known as Rojava in 2016.

Then, on October 6th, President Donald Trump ordered the American troops stationed in north-eastern Syria to withdraw. On October 9th Turkey invaded. Four days later the Kurdish militia which ran Rojava, the People’s Protection Units (YPG), made a deal with Mr Assad at Russia’s Khmeimim air base, in the north-west of Syria; if the Syrian army came into Rojava to protect his country’s territory against the Turks, the Kurds would fight alongside him.

A video released by Russian state media soon afterwards showed Syrian troops advancing past Americans withdrawing down the same road, their respective pennants flapping in the wind.

With his flag now flying over towns such as Hasakah, Kobani and Qamishli, and with control of the country’s two largest dams, Mr Assad has reclaimed more north-eastern territory in a few days than he previously had in a few years.

Mr Trump’s decision has reshaped the Levant. Now expanded to include almost all American troops in Syria, it has ensured that America will have no influence over the final settlement of Syria’s civil war. That will be orchestrated by Russia, which benefits greatly from the new situation. Being a friend to Turkey and Syria alike is potentially tricky while fighting continues. But it is a good position from which to broker its end.

The president’s decision has also left American allies around the world newly worried that they too could be left in the wind, just as the Kurds have been. It has put new strains on NATO. And it has given IS a chance to rise again.

Turkey says its invasion is an act of self-defence. The YPG is linked to the Kurdistan Workers’ Party (PKK), a group responsible for dozens of deadly attacks across Turkey since its peace talks with the government of President Recep Tayyip Erdogan broke down in 2015. America’s decision to arm and work with the YPG during the fight against IS was widely seen in Turkey as an act of betrayal.

At the Turkish border troops returning from Syria are welcomed by children saluting and making victory signs. Those who challenge the mood too obviously risk joining more than 186 people detained on terrorist charges for social-media posts critical of the invasion. “People who classify this as a war”, as opposed to a counter-terrorism operation, Turkey’s interior minister, Suleyman Soylu, has said, “are committing treason.”

When backed up by Western air power in the fight against IS the YPG had been a pretty effective force, though the Kurds still lost 11,000 fighters in the struggle. With neither air support nor armour, the militia was no match for Turkey’s army, the second largest in NATO.

Turkey quickly took a section of the M4, an east-west highway about 30km south of the border, cutting the YPG’s supply lines. Much of the advance has been led by ill-disciplined Syrian rebels, a tactic which both reduces Turkish casualties and provides deniability when it comes to crimes such as the murder of Hevrin Khalaf, a Kurdish politician, and the roadside execution of prisoners.

Following the deal with Mr Assad, YPG forces are now under the command of the Syrian army’s Fifth Corps. This is said by the YPG to be a purely military arrangement. The Kurds purport to believe that the bits of Rojava to which government forces have returned can continue to be run as they were before, with “the self-administration’s government and communes intact”, in the words of one official.

But Mr Assad’s regime does not have a history of forbearance with populations returned to its control. Promises of local autonomy made when it retook the southern province of Daraa were quickly broken. “Reconciliation” deals with the locals ended with people jailed or pressed into military service.

In the north-east, Kurds and Arabs who worked with the Americans will be particularly vulnerable to such reprisals. The hasty withdrawal left no time to whisk them out; more than one official likened the situation to the fall of Saigon in 1975. Nor is it easy for people to leave under their own steam. Iraqi Kurds have closed their border to Syrians, Kurdish or otherwise, unless they are sick. Most of the 160,000 people estimated to have been displaced are heading south.

The departing Americans did manage to exfiltrate some of the most notorious IS prisoners being held in north-eastern Syria. But they left behind a great many more. More than 70,000 prisoners taken from the former caliphate—a mix of IS fighters, their families and civilian refugees—are held in camps dotted across north-east Syria. The Kurds who have been guarding them now have other priorities. On October 13th over 800 IS-linked detainees escaped from Ain Issa camp in the chaotic aftermath of Turkish shelling. More will follow.

Jailbreaks will give the battered rump of IS fresh manpower. Mr Assad’s return will give it a new rallying cry—IS will be able to present itself as a pre-eminent adversary. The bits of IS still running a low-level insurgency in northern and western Iraq may be revived, too. All of this is a return to form. IS has been “defeated” before, only to regroup in ungoverned spaces with angry populations. Its blitz across Iraq in 2014 was made possible by massive jailbreaks.

Perfidious America

If IS does rise again, Mr Trump will blame the Kurds. Most others will blame him. American allies in the region felt let down by President Barack Obama, who made a deal with Iran and refused to strike Syria. They hoped Mr Trump would suit them better. King Salman of Saudi Arabia gave him a gilded reception in Riyadh in June 2017. Binyamin Netanyahu, Israel’s prime minister, all but anointed him the messiah.

The welcome given to Russia’s president, Vladimir Putin, when he arrived in Saudi Arabia on October 14th did not have all the bells, whistles and ceremonial swords accorded to Mr Trump two years ago. But his visit, and his promise “to reduce to zero any attempt to destabilise the oil market”, were still significant. So was his subsequent trip to Abu Dhabi.

Despite their differences on Syria—differences which are fading as Arab states quietly reconcile with Mr Assad—Gulf leaders have noted that it was Russia, not America, that stood by its partner. They also note that, for all Mr Trump’s bellicosity, he has done little to stop Iran becoming more assertive—and indeed attacking major oil installations.

The 1,800 American troops deployed to Saudi Arabia on October 11th do not lay those worries to rest, though they do show that Mr Trump’s aversion to foreign entanglements is untroubled by consistency.

Israel is distinctly fretful at the sight of an American ally so swiftly thrown aside. Mr Netanyahu did not mention Mr Trump directly when he condemned Turkey’s attack and warned against “the ethnic cleansing of the Kurds”. Some of his ministers are less cagey.

The purpose of America’s remaining deployments in Syria, in the south-east, is to stop the creation of a permanent supply line between Iran and the Hizbullah forces it supports on Israel’s borders. Should those troops leave too, Israel will be yet more alarmed.

Seeing America’s stock fall so precipitously has alarmed many in Washington. Democrats were quick to make hay. Republicans in Congress were vocal, too. They have frequently made foreign policy an exception to their general rule of not criticising the president’s breaches of decorum and reason.

Even given that track record, though, the dissent from Mr Trump’s decision was striking. Lindsey Graham of South Carolina, a national-security hawk and erstwhile Trump whisperer, called in to one of the president’s favourite television shows to berate him. “I fear this is a complete and utter national security disaster in the making,” Mr Graham later tweeted.

Congressmen from both parties argue that, although they realise that Americans have had enough of foreign wars, abandoning brave allies and letting IS regroup are beyond the pale. On October 16th a measure condemning Mr Trump’s decision passed in the House by 354 to 60, with 129 Republicans voting against the president.

That enraged Mr Trump, who maintains that his decision was “strategically brilliant”. The White House has released a letter threatening Mr Erdogan with the destruction of the Turkish economy if he were to take bloody advantage of the opportunity Mr Trump had provided him with: “Don’t be a tough guy. Don’t be a fool!” If this was sincere it was somewhat belated, being sent on the day of the invasion.

Mr Trump has dispatched Mike Pence to Turkey to press for an immediate ceasefire, though his boss’s professed lack of interest in the fate of the Kurds seems likely to undercut the vice-president’s position. On October 14th he also announced penny-ante sanctions. Mr Graham and Chris Van Hollen, a Maryland Democrat, have crafted a more muscular package.

The crisis has also triggered another threat to Turkey’s economy, albeit indirectly. On October 16th prosecutors in New York unsealed an indictment against Halkbank, one of Turkey’s biggest state lenders, accusing “high-ranking” Turkish officials of operating a scheme to bypass American sanctions against Iran. Mr Trump is reported to have tried to stymie aspects of this case at Turkey´s bidding.

According to Timothy Ash, an analyst at BlueBay Asset Management, the fact that the prosecutors have now made their move shows that “developments in Syria and impeachment have broken the dam.” The news had an immediate impact on Turkey’s banking sector. The bank index dropped by 4%, with Halkbank shares down 7.2%. The government banned short-selling in the stock of Halkbank and six other banks.

Mr Graham also talks of suspending Turkey from NATO. This is nonsensical: the North Atlantic Treaty offers no mechanism for suspensions or expulsions. What is more, Turkey really matters to NATO; its well-trained forces, on which it has been spending a lot, are woven deeply into the alliance’s fabric.

The NATO land command is hosted in Izmir; one of its nine “high-readiness headquarters”, which could command tens of thousands of troops in a crisis, is just outside Istanbul. Turkey’s navy plays a key role in the Black Sea, a priority since Russia seized Crimea.

It has almost 600 troops in NATO’s mission in Afghanistan. Radars on its territory scan the skies between Iran and Europe for missiles. And it hosts American B61 nuclear bombs as part of NATO’s nuclear-sharing scheme.

Turkey and its NATO partners have been increasingly at odds over the past few years. America’s embrace of the YPG was one factor. So was the dismissal of thousands of Turkish officers after the attempted coup against Mr Erdogan in 2016; “A drastic de-NATO-isation of the Turkish armed forces” as a report for the Clingendael Institute, a Dutch think-tank, puts it. Turkey’s purchase of the S400 air-defence system from Russia made matters worse.

An EU arms embargo enacted on October 14th will hurt Turkey: about a third of its arms imports come from Spain and Italy. But if such actions push it towards a negotiating table, it will be a table supplied by the Russians—who will be quite happy to supply arms, too, as part of an eventual deal. While it will remain part of the alliance, Turkey may start fielding ever-less-interoperable weapons, and sharing ever fewer goals.

It may also rethink its attitude to Syrian refugees. Part of Turkey’s justification for its excursion into Syria is the creation of a safe space to which Syrian refugees can return—or, if necessary, be sent. If stymied, it might yet decide instead to let them through into Europe.

Some, though, will not go anywhere. In Akcakale on the Turkish-Syrian border, Ahmet Toremen, a construction worker, walks past the broken window-frames, burnt mattresses and bloodstains covering the bottom floor of his ramshackle house. It was hit by Kurdish mortar fire from Syria.

At least 20 civilians have died in such attacks, according to officials in Ankara. For Mr Erdogan their deaths offer a chance to show that the war was a matter of necessity, not choice.

He can rely on no Turkish newspaper pointing out that there were no such attacks before October 9th, just as they do not report the civilians being killed in Syria.

On October 16th the Syrian Observatory on Human Rights put this toll at 71, along with 15 killed in an air strike on a humanitarian convoy.

Mr Toremen’s family was next door when the shell landed in the corner of their living room; the house had been rented out to a Syrian family.

One woman was blinded, one wounded and the family’s baby was killed.

“They escaped war”, says Mr Toremen, “and war found them here.”

Inflation Outlook Supports Gold's Long-Term Uptrend

by: Clif Droke

- Low inflation expectations are why gold's long-term prospects are bullish.

- Recent trade relation improvement is a short-term headwind, though.

- Persistent low inflation will eventually overcome gold's latest obstacle.

It’s a commonly held assumption that gold benefits primarily from inflation.
If that were entirely true, then there should be no reason for gold to be struggling against the prospects of increasing inflation now that trade relations between the U.S. and China are being patched up.
The idea that gold loves inflation is only partially true, however.
What gold responds to more than anything else is the fear of the unknown.
As I’ll explains here, strong evidence for a lack of inflation supports gold’s longer-term uptrend in the year to come.
On a short-term basis, however, gold faces a headwind from the recent improvement in the global trade Outlook.
Gold’s popularity is always greatest during periods of political or economic turmoil. That includes periods of runaway inflation, such as the U.S. experienced in the late 1970s.
But when the inflation rate is coming off extremely low levels and only gradually increases, this isn’t a reason for investors to fear the economic consequences.
To the contrary, a healthy dose of inflation following a period of low inflation (or deflation) would be quite beneficial for the economy and would also be a reason for investors to sell gold and rotate into assets that would benefit from an improved economic growth outlook.
Low inflation rates, by contrast, imply low levels of economic growth. When the economy fails to realize its long-term growth potential, investors get nervous and accordingly start looking around for safe places to hedge their investments.
Gold is naturally one of the first assets they turn to in their quest for safety.
Indeed, gold’s bull market since last year is at least partially predicated on the market’s worries over sub-par inflation rates.
There has been some speculation among financial commentators, however, that the U.S. and the developed world might finally be heading out of the prolonged period of low inflation in 2020.
Yet there are no signs to date that inflation is anywhere on the horizon.
This is one reason for believing that gold’s longer-term bull market is still intact, even if the yellow metal is struggling to re-establish its forward momentum in the immediate term.

Virtually all the latest major economic reports confirm the near-absence of inflation. Last week it was announced that U.S. consumer prices were unchanged for September as inflation was acknowledged to be in “retreat.”
According to the Labor Department, the flat consumer price index for September recorded its weakest reading since January.
Worries about slowing global growth and continued chaos over Britain’s planned exit of the European Union have contributed to the decline in business investment spending and lower commodity prices.
Not only do the economic numbers testify to the lack of threat posed by inflation, but consumer sentiment reflects continued fears that low inflation is still a problem.
The latest New York Fed survey, for instance, revealed that the inflation outlook for U.S. consumers was muted in September and fell to its lowest level on record over a 3-year timeframe since the bank began its monthly consumer expectations survey in 2013.
This should be regarded as good news for long-term holders of gold or gold-related assets.
On a short-term basis, however, investors aren’t overly worried that the inflation rate will continue to decline.
One way to measure the extent to which inflation prevails on a short-to-intermediate-term basis is to compare the gold and copper prices from a relative strength perspective.
Not only does the copper/gold ratio be used to show where long-term Treasury yields should ideally be (based on current inflation rates), but the gold/copper relationship is useful for gauging the safe-haven demand for gold as well.
When the price of copper is weak relative to gold for a period of several weeks-to-months, it implies that investors have serious concerns about the rate of global growth.
Historically, copper is weak versus gold, investors turn to gold and other safety-oriented assets (namely Treasuries) as an insurance policy against a slowing economy.
Shown here is a ratio comparison of the gold versus the copper price in the last two years.
This graph underscores the tendency for rallies in the gold/copper ratio to precede declines in the gold price.
The reason for this is that relative strength in copper suggests that investors’ confidence in the global outlook is temporarily on the rise after the latest improvements in U.S.-Sino trade relations.
When investors are feeling more assurance about the economic growth outlook, they tend to move away from safe havens like gold and turn to risk assets like equities.
This partly explains why the gold price has remained stuck in a trading range since peaking in September.
Copper vs. Gold Price Source: StockCharts
When the copper/gold ratio is trending lower, however, it implies investors are definitely concerned about slowing global growth.
This was the case in late 2018 and also during the May-August period this year.
The downward trend in the gold/copper ratio shown above illustrates these two periods of worry.
Based on the copper/gold relationship described here, it should come as no surprise that gold’s best performance this year so far was during this period when investors were deeply worried about the U.S.-China trade war and its potential impact on the global economy.
Lately, however, investors have received assurances from the governments of the U.S. and China that they are collectively working toward an agreement which would mitigate the impact of trade tariffs on both sides.
Currently, the copper/gold ratio is above its 15-day moving average and is also above its year-to-date low.
This reflects the short-term headwinds standing in the way of higher gold prices, namely increased investor confidence in the short-term outlook.
Indeed, the bounce in this ratio in September was enough to scare off new gold buyers and also encouraged traders to book some profits in existing long positions in the yellow metal.
But the copper/gold ratio hasn’t reversed its long-term downward trend and this implies that the inflation outlook is still muted. It further suggests that the long-pull bull market for gold which began last year is still very much intact.
On a short-term basis, however, as long as the gold/copper ratio remains above its 15-day moving average, gold’s immediate-term (1-4 week) trend will remain unsettled and new highs in the gold price will have to wait.
What’s more, if the copper price starts to rally on perceptions that China’s industrial outlook is strengthening then we may even see some downward pressure on the gold price.
Yet there are still plenty of geopolitical and global economic uncertainties to keep

Meanwhile, the copper/gold ratio is current at 0.0018, which is telling us that the U.S. 10-Year Treasury Yield Index (TNX) should be at around 1.80%.
Currently, the 10-year yield is at just under 1.80%, almost exactly where it should ideally be according to the ratio.
The recent rally in TNX represents a an improvement from the last several months when yields were plummeting to unnaturally low levels, due largely to the panic over a global slowdown.
Those fears have been temporarily suspended thanks to the latest developments on the global trade front.
But by no means should investors assume that trade-related worries are a thing of the past.
Accordingly, long-term gold investors are justified in maintaining investment positions in the metal.
CBOE 10-Year Treasury Yield Index Source: BigCharts
However, the higher low that was established in the copper/gold ratio since September is enough to warn investors to steer clear from initiating new long positions in gold for now.
Gold will likely continue to struggle against the efforts of the major industrial nations to lower or eliminate tariffs.
Moreover, until the gold price closes at least two days higher above its 15-day moving average (below), gold will remain vulnerable to any positive news developments on the trade front.
Gold Continuous Contract Source: BigCharts
In conclusion, the bull market for gold which began last summer is still being supported by geopolitical concerns and global growth worries.
What's more, an outlook that points to continued low inflation in the coming years is supportive of bullion prices.
On a near-term basis, however, investors should exercise caution and wait until the next technical breakout signal is confirmed in the gold price before adding to existing long positions.

On a strategic note, I’m waiting for both the gold price and the gold mining stocks to confirm a breakout before initiating a new trading position in the VanEck Vectors Gold Miners ETF (GDX), my preferred trading vehicle for the gold mining stocks.
I’m currently in a cash position in my short-term trading portfolio.